THE commodities and energy sector is on the cusp of a multi-year boom in investment flows, and hedging activity is set to surge, but margins will remain thin as competition escalates, a senior Societe Generale executive said.
"As overall demand picks up, we're seeing a lot more requests for hedging tools,"
Mr Angel Archuleta, the head of energy trading for the French bank's commodities- derivatives group in Asia, told Reuters in an interview. "We expect demand to continue picking up, not just in energy, but also in bulks, metals, gas.
We see the need for commodity risk mitigation across the board, so that's encouraging."
Recent fund flows into the commodities sector pushed key indicators - such as the Reuters- Jefferies CRB Index, the S&P Goldman Sachs Commodities Index, and the Dow Jones UBS Commodity Index - to their highest levels since October 2008 early last month.
Both the Dow Jones UBS index and the Reuters-Jefferies CRB Index hit one-month peaks of 156.72 and 317.29 respectively this month, while the S&P Goldman Sachs Commodities Index touched an all-time high of 619.59 in intra-day trade.
"Looking at the flow picture six months ago, clients were concerned about margins upfront, and making sure the business was able to run, with the tenure of trades just one or two quarters ahead," Mr Archuleta said.
"Now, we're seeing more aggressive programmes from consumers to refiners, where the scope and tenure have increased. For example, calendar trades are being looked at; 18-month forwards are being looked at."
On a broader scale, growth prospects are bright, with the global commodities and energy sector in the nascent stages of a boom phase, and a new paradigm of commodity investing and consumption coming into play, he said.
"Commodities will no longer be part of the finance class where it comprises just 2 to 5 per cent of your asset-allocation model. It's now a legitimate investment class, with the boom in ETFs and different mutual and hedge funds that are more resource-based," he said, referring to exchange-traded funds.
"As an investment tool, as a hedge, we're going to see unprecedented levels of activity. It's going to push price levels, interest, demand, everything, forward. Whether this is going to create a bubble, well, we're going to need prudent risk management," he added.
Asia will benefit from the implementation of the Volcker rule in the United States, which blocks banks from trading with their own money, known as proprietary trading.
"With the disbanding of 'prop-trading' groups at US banks, those businesses will not disappear, but come up in new forms, and, without a doubt, the beneficiaries would be Asia and Europe. That will definitely increase trading flows out here," he added.
But even with exponential growth in flows and the sector as a whole, margins are likely to stay compressed and will not return to pre-2008 levels.
"Margins will not improve much next year. They're still going to be tight," Mr Archuleta said.
"The competition we've seen from the number of banks participating in hedging activities has escalated over the past few years. Next year will still be challenging for everyone."
With more players jostling for a slice of the lucrative pie, and the launch of various products traded on exchanges, price transparency has increased, further pressuring margins.
"An average bid-offer spread that used to trade in, for example, US$0.25 (S$0.33) increments, is now being looked at in US$0.05 increments," Mr Archuleta said.
"The increase in price transparency as demand grows is going to make for a very, very competitive landscape."
To mitigate the squeeze, Societe Generale is looking at bundling its trade-financing offerings with hedging tools to make the bank a one-stop shop for customers.
"It's a very tough business just pushing hedging. We're looking at leveraging our trade-financing solutions and providing a complete package for our clients," Mr Archuleta added.
Societe Generale expects to grow its trade-financing volumes in Asian commodities by 45 per cent this financial year, exceeding an earlier forecast of 20-25 per cent, Mr Eric Saux, the co-head of energy and commodities finance in Asia, told Reuters.
"People are moving more and more from an oil market to an energy focus, with a clear focus on oil and gas," Mr Saux added.
http://www.asiaone.com/Business/News/Story/A1Story20101209-251702.html
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